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Expiration Day Effects of the EURO STOXX 50 Index Futures and Options

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Expiration Day Effects of the EURO STOXX 50 Index Futures and Options Expiration Day Effects of the EURO STOXX 50 Index Futures and Options Finance Master's thesis Markus Joensuu 2010 Department of Accounting and Finance Aalto University School of Economics Expiration Day Effects of the EURO STOXX 50 Index Futures and Options Master’s Thesis Markus Joensuu Spring 2010 Finance Approved in the Department of Accounting and Finance __ / __20__ and awarded the grade __________________________________________________________________________ Aalto University School of Economics ______________________________________________________________________________ Aalto University School of Economics ABSTRACT Master’s thesis 21.5.2010 Markus Joensuu EXPIRATION DAY EFFECTS OF THE EURO STOXX 50 INDEX FUTURES AND OPTIONS PURPOSE OF THE STUDY The purpose of this thesis is to bring new evidence on index derivatives’ expiration day effects in Europe. The study addresses the lacking evidence on the expiration day effects of the EURO STOXX 50 index futures and options, which are among the most traded index derivatives in the world. The thesis studies the abnormal volume, return, volatility and return reversal effects around the monthly options and quarterly futures expiration days. Furthermore, this study examines whether some of the effects are spilled over from the EURO STOXX 50 index to OMXH25 via Nokia, which is a member of both indexes. DATA The data used in this study consists of EURO STOXX 50 constituents’ daily trading volume and return figures as well as monthly index weights from Datastream. Furthermore, 15 second interval high frequency index price data from STOXX Ltd. is used to compare the intraday volatilities and returns on expiration days to the control group of non-expiration days. The futures expiration day sample includes 40 trading days, the options sample 80 days and the control group 401 days, covering the years 2000-2009. Furthermore, daily high, low, and closing prices, as well as monthly and semiannual weightings and component lists of OMXH25 index constituents are used. This data is from Nasdaq OMX and Datastream. RESULTS I find significant expiration day effects around the expiration of EURO STOXX 50 index derivatives. The effects are in general stronger for the expiration of futures than for options. The results show that expiration days are associated with a significantly higher trading volume on the underlying index. This is due to the unwinding of delta positions and to heavy program trading activities on expiration days. Furthermore, a significantly higher intraday volatility around the expiration time at 12:00 CET on expiration days is found. This result is robust also when controlling for sample size differences. Moreover, the intraday returns before expiration are significantly higher and the returns after expiration significantly lower on expiration days. The returns before 12:00 CET tend, on average, to reverse more on expiration days after 12:00 CET than on non-expiration days. The finding regarding reversals suggests that trading is liquidity driven on expiration days and supports theory on the inventory considerations of market makers. Moreover, the systematic direction of the return effect is a sign of potential price manipulation activities and/or on average a significant unwinding of short positions on expiration days. However, no significant evidence of expiration day effects spilling over from the EURO STOXX 50 index to OMXH25 via Nokia is found, at least when studying daily data. KEYWORDS Expiration day effects, index arbitrage, program trading, liquidity, return reversals. Aalto Yliopiston Kauppakorkeakoulu ______________________________________________________________________________ Aalto Yliopiston Kauppakorkeakoulu TIIVISTELMÄ Pro Gradu-tutkielma 21.5.2010 Markus Joensuu EXPIRATION DAY EFFECTS OF THE EURO STOXX 50 INDEX FUTURES AND OPTIONS TAVOITTEET Tämän tutkielman tavoitteena on tutkia indeksijohdannaisten erääntymispäiväefektejä Euroopassa. Tutkielma keskittyy EURO STOXX 50 indeksifutuureihin ja -optioihin, jotka kuuluvat maailman eniten kauppaa käytyihin indeksijohdannaisiin. Ensinnäkin, tutkielmassa tarkastellaan indeksin epänormaalia kaupankäyntivolyymiä, tuottoja, volatiliteettiä sekä tuottojen kääntymistä erääntymispäivinä. Lisäksi tutkielmassa tarkastellaan mahdollista erääntymispäiväefektien leviämistä EURO STOXX 50 indeksistä OMXH25 indeksin osakkeisiin Nokian kautta. AINEISTO Tutkimuksen aineisto koostuu EURO STOXX 50 indeksin osakkeiden päivittäisistä kaupankäyntivolyymeista, hinnoista sekä osakkeiden indeksipainoista. Tältä osin aineisto on koottu Datastream tietokannasta. Lisäksi tutkielman keskeisenä aineistona käytetään STOXX Ltd:ltä saatuja EURO STOXX 50 indeksin päivänsisäisiä 15 sekunnin välisiä hintoja. Päivänsisäistä dataa käytetään erääntymispäivien (120 päivää) vertaamiseen kontrollityhmään (401 päivää) kattaen vuodet 2000–2009. Lisäksi päivätason tuottoja, päivän ylimpiä, alimpia ja viimeisiä hintoja, sekä puolivuosittaisia indeksipainotuksia käytetään analysoitaessa OMXH25 indeksiä. Tältä osin data on Nasdaq OMX:sta ja Datastreamista. TULOKSET Tutkielman tulokset osoittavat ensinnäkin, että EURO STOXX 50 indeksijohdannaisten erääntyminen aiheuttaa merkittävästi korkeampaa kaupankäyntivolyymiä kohde-etuutena olevaan indeksiin tavalliseen päivään verrattuna. Syynä tälle voidaan pitää indeksiarbitraasia sekä delta-positioiden purkua erääntymispäivien yhteydessä. Lisäksi havaitaan, että erääntymispäivien päivänsisäinen volatiliteetti erääntymishetken ympärillä on tavallista merkittävästi korkeampi. Tuotot ennen erääntymishetkeä ovat merkittävästi korkeampia, kuin muina päivinä. Vastaavasti tuotot erääntymishetken jälkeen ovat merkittävästi tavallista alhaisempia. Erääntymishetkeä edeltävät tuotot kääntyvät keskimäärin voimakkaammin erääntymispäivinä erääntymishetken jälkeen, viitaten vahvaan likviditeettijohteiseen kaupankäyntiin erääntymispäivänä. Tuottojen kääntyminen tukee teoriaa markkinatakaajien varastointirooliin liittyvästä tuottovaatimuksesta. Lisäksi tulokset tuottojen systemaattisen suunnan osalta ovat merkki mahdollisesta kurssimanipulaatiosta ja/tai tavallista suurempien lyhyeksi myytyjen positioiden sulkemisista erääntymispäivien yhteydessä. Toisaalta tutkielman tulokset eivät osoita merkittävää erääntymispäiväefektien tarttumista Nokiasta muuhun OMXH25 indeksiin. AVAINSANAT Erääntymispäiväefektit, indeksiarbitraasi, program trading, tuottojen kääntyminen. I Table of Contents 1. Introduction ................................................................................................................................. 1 1.1. Background and motivation ................................................................................................. 1 1.2. Research questions ............................................................................................................... 3 1.3. Contribution to existing literature ....................................................................................... 3 1.4. Results ................................................................................................................................... 4 1.5. Limitations of the study ........................................................................................................ 6 1.6. Structure of the study............................................................................................................ 7 2. Stock index futures, stock index options and delta hedging ................................................ 8 2.1. Stock index futures and options ........................................................................................... 8 2.2. Delta hedging...................................................................................................................... 10 2.3. Do options and futures trading affect the cash market? .................................................. 11 3. Literature review ...................................................................................................................... 14 3.1. Previous studies on expiration day effects ........................................................................ 14 3.1.1. Expiration day effects in the US and Canada ............................................................... 15 3.1.2. Evidence on expiration day effects from Europe ......................................................... 17 3.1.3. Expiration day effects in Asian and Australian markets.............................................. 18 3.2. Sources of expiration day effects ....................................................................................... 20 3.2.1. Existence of index arbitrage opportunities ................................................................... 20 3.2.2. Cash settlement ............................................................................................................... 21 3.2.3. Manipulation activities ................................................................................................... 22 3.2.4. Stock market procedures ................................................................................................ 24 3.3. Cash market volatility, volume, and price reversals ........................................................ 25 3.3.1. Studies on the relationship between price volatility and trading volume ................... 26 3.3.2. Evidence on the relationship between reversals and liquidity trading ........................ 28 3.4. Studies on co-movements of stocks ...................................................................................
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